The State of the States: Post-Bernanke Bellum

One can almost imagine ex-chairman Bernanke shaking his head in disbelief.
(For the record, I cannot conceive of Simple Ben possessing the capacity
for what follows, so this is an indulgence in creative writing.):

"I gave them every opportunity to get out of the mess they had created. Here
we were, after the bust in 2009, a generation of irresponsible and sometimes
criminal municipal management was obvious. States and cities had spent money
like a ship full of drunken sailors, who then sold the ship to keep drinking.
They built the most unnecessary monuments to satisfy contractor payoffs, union
shakedowns, and school-board extravagances." [Bloomberg, January 24, 2014 - "Engineers
spotted 'hundreds' of cracks in welds on parts produced for the San Francisco-Oakland
Bay Bridge in 2008 and were encouraged to stay quiet rather than delay the
$6.4 billion project.... 'This is the first time in my career the engineering
wasn't allowed to be done right,' said Douglas Coe, a former Civil Engineer
for the California Department of Education."]

"The phony housing boom had mushroomed property tax receipts, but even these
temporary handouts had not been enough to balance their budgets. I have done
my best to keep property-tax receipts at such an inflated level ["Home prices
in 20 cities climb by most in seven years" - Bloomberg, December 31, 2013],
but only a fool could think the central bank can keep prices for 100 million
houses rising forever. The huge increase of income tax, sales tax, and capital-gains
receipts had also increased beyond belief. This once-in-a-century transfer
could not sate these spendthrift governments.

"We at the Fed ignored the preposterous 8% earnings rate assumption made for
public-pension assets. This assumption extends into the hereafter. All I could
give them was through 2013. I produced 8% rates-of-return across markets for four
years! This was their chance to get their affairs in order; to whittle
down the rate-of-return for the future when markets are bound to regress. [As
I said, this goes well beyond Ben's potential imagination. - FJS] To stop spending
as if the Fed could QE their pleasure palaces without losing the world's trust
in the dollar. To stop building professional football fields when consumers
could not possibly continue their animalistic buying, with incomes falling.

"We worked every contrivance to keep them doing so. Such as: Financial
Times - January 24, 2014: 'In Vegas, a panel on securitizations of subprime
auto loans - made to riskier borrowers who want to buy cars - was standing
room only. Investor demand for the higher-yielding securities has led to
intense competition to originate and bundle the auto loans.... 'At some point
there will be a failure [of a subprime auto lender]. There will be some consolidation,'
said Chris D'Onofrio, of rating agency DBRS." [Not mentioned in the story,
but you may have gathered from the "intense competition," most subprime auto
loans now being made are to buyers (sort of) whose credit is so poor, they
do not even have credit scores. - FJS]

"I offered an opportunity to municipal bond markets: for ratings firms and
bond managers to read the fine print. To understand municipalities had started
(by 2009) to borrow for operating expenses, even the operating expenses
they were forecasting, two or three years in the future. All of this
is illegal and remains unspoken.

"We at the Fed thought [sic - FJS] municipal bond managers would pick
and choose through the wheat and chaff. Yet, today, almost every municipal
bond fund has at least one percent of its assets in Puerto Rican bonds. I knew
the average mind at the FOMC was senile, but what gives with these managers?
Their funds are often leveraged. And the rubbish being sold is as revolting
as the justification for these issues. For example, from Bloomberg, December
17, 2013: 'Phillips Academy, the oldest incorporated boarding school and one
of the most exclusive, is tapping the municipal bond market for over $80 million
this week in new money and refunding debt....The school has an endowment of
$869 million. The fall, 2013 enrollment was 1,129. Only 13% of the applicants
were admitted.... 'These schools need to compete for students and invest in
their facilities,' said [Susan] Fitzgerald, [senior vice president at Moody's].'

"She's a senior vice president? I can get away with not knowing what I am
talking about before a bunch of senators, but she has a real job. Or, maybe
not."

"And now, reading the Wall Street Journal from January 31, 2014: "DETROIT
- This bankrupt city is proposing to favor pension funds at roughly double
the rate of bondholders to resolve an estimated $18 billion in long-term obligations..."

Note: The question of pensions vs. bondholders will probably wind its way
to the Supreme Court, even though there are many jurisdictions. In the meantime,
there will be plenty of reasons for municipal bondholders to run, the Puerto
Rican holdings being immediately pertinent.

Sheehan serves as an advisor to investment firms and endowments. He is the
former Director of Asset Allocation Services at John Hancock Financial Services
where he set investment policy and asset allocation for institutional pension
plans. For more than a decade, Sheehan wrote the monthly "Market Outlook" and
quarterly "Market Review" for John Hancock clients.

Sheehan earned an MBA from Columbia Business School and a BS from the U.S.
Naval Academy. He is a Chartered Financial Analyst.